Special Report: Will Natural Gas Save the Canadian Oil and Gas Industry? Part 2

With no resolution in sight for the high Western Canadian Select and West Texas Intermediate differentials, in addition to government policy and legislation that threaten to destroy Canada's oil and natural gas industry, coupled with low natural gas prices, many are wondering how Canada’s energy industry will survive. Yet, a credible case can be made for strong natural gas prices in the next few years.

 

This special report will start with an overview of the North American natural gas industry and conclude with reasons as to why we should be very optimistic about the not-so-distant future.

Part II: LNG Export Infrastructure and The Industry’s Ability to Deliver

 

In 2016, Cheniere Energy opened the first of six trains of the USD $18 billion Sabine Pass liquefied natural gas (LNG) export terminal, in an industry where 15 to 20-year take-or-pay contracts are the norm. Train number six is scheduled to open in 2019.

 

Appellation gas is now being shipped from the first of four trains from the USD $4 billion Cove Point export terminal in Maryland (0.8 BCF/day), to India under a 20-year take-or-pay contract.

 

U.S. Plans for More LNG Terminals

 

  • Six terminals of 8.1 BCF/day approved and under construction

  • Four terminals 6.8 BCF/day approved and not yet under construction

  • Twelve terminals of 21.78 BCF/day are proposed

Major capital projects require sales contracts before financing commitments are made.  While assumptions are that end users will be signing those sales contracts, 60 percent of the contracts for the U.S. terminals are with LNG traders.

 

In spite of this positive news, Art Berman continues to ask questions about the profitability of shale wells.  On September 3, 2018 Mr. Berman posted a chart showing that “88% of the sampled gas-weighted E&P companies had negative cashflow in Q2 2018.” This was a follow-up to his March 3, 2018 posting, “Shale gas is marginal at best. 79% of companies lose money (capex > cashflow from operations).

 

 

The obvious question is how long can the oil and gas industry continue to raise money when most natural gas weighted companies are losing money?  Factoring in recent strong growth in the U.S. economy means there are now more choices of business sectors to in which to investment.  Sector Rotation of Capital is the term used to describe it.  If that happens, then fewer wells will be drilled and total U.S. gas production will decline.

 

The next chart shows anticipated sources of energy and the market sectors expected to be utilizing it.  The Energy Information Administration (EIA) is forecasting renewable energy to make insignificant gains in the energy source mix. A lot of weight is riding on American producers to deliver natural gas volumes to the U.S. over the next 30 years.

 

The electricity generation sector has been trending towards natural gas, away from coal. That, along with the operational needs of industrial customer, means increased domestic consumption and less available for export contracts.

 

 On September 4, 2018, Mr. Berman pointed out that the world’s largest cargo carriers and cruise lines have ordered 125 new LNG powered ships, and that LNG bunker demand will be further increased by this previously unidentified LNG market, which could account for 13 percent of long-term demand growth.

 

EIA Forecasts

 

On November 23, 2018, Forbes reported that the U.S. could be the world’s largest exporter before 2025. On November 19, 2018, Singapore Business Review wrote, “The increasing gas demand from Asia is feared to push the global liquefied natural gas (LNG) market into a deficit in 2022-2025 as the region struggles to meet its booming energy requirements, according to an analysis by Fitch Ratings.

 

It has been eleven years since the Barnett shale gas production ramped up, and now multiple commentators are saying that all drilling has ceased and it is in terminal decline.  Seven years ago, the Marcellus began a resurgence with tight shale drilling.  With new pipelines in service, drilling and production are expected to increase, but at some point in the near future, based on the production profiles of all other shale plays, Marcellus shale gas production will begin its terminal decline.

 

In January 2017, the U.S. EIA put out its Annual Report, which was far more comprehensive than their 2018 edition:

Canadian Geologist, J. David Hughes, in his Shale Reality Check, Winter 2018, had the following observations about the EIA report:


- The EIA assumes that 96% of its estimate of a total remaining potential of 286 tcf (Proven Reserves (2015) of 72.7 tcf, plus Unproven Resources (2015) of 211.2 tcf) will be recovered by 2050.

- That is more than three times the USGS estimate., which is 84 tcf.

- To meet the Marcellus EIA forecast, 132,163 more wells will have to be drilled, 11 times more than have been drilled already, at a cost of $793 billion.

- Service company costs are rising, and where will all that frac sand and water come from, at what prices?

- Shale production is to increase by 49% by 2050.

Note the Canadian imports in light blue of the following chart:

 

This begs the question: if 96.4 percent of the estimated remaining potential is produced by 2050, what will be produced in 2051?

 

Mr. Hughes extended his calculations to determine that for the EIA estimate to come true, over one million wells would have to be drilled, at a cost of over USD $5.7 trillion just for the shale gas wells.  Once conventional and off-shore estimates are included, the numbers increase to 1.29 million wells, at an estimated cost of USD $7.7 trillion.  By this point in his report, writing that the play-level EIA forecasts are “highly to extremely optimistic, and therefore highly unlikely to be realized” seems rather obvious.

 

Throughout the entirety of this special report, possibly the most important point is that billions of dollars are being spent on LNG export terminals and ships, supply contracts are being signed, and other important and government decisions are being made based upon EIA estimates like these.

 

Take-or-pay contracts are thought of as a one-way guarantee, but the ability to take comes with the obligation to supply.  What if the U.S. oil and gas companies cannot deliver the LNG because they no longer have the enough natural gas production?

 

Our Forecast for the Canadian Oil and Gas Industry

 

  • Natural gas prices will increase by far more than Canadian industry reserve report estimates of about $3.00/mcf AECO-C in 2022.

 

  • The U.S. will need Canadian natural gas to meet their long-term needs, and this will drive prices much higher than are being forecast.

 

Within the next five years, as more U.S. LNG terminals are ready to start exporting, U.S. natural gas production will fall short of EIA estimates.  This will give Canada a big opportunity to sell its natural gas, without the barriers that have blocked the Keystone pipeline, nor a commodity price differential plaguing Canadian oil.

 

What does the Canadian oil and gas industry need to do in preparation for that opportunity?

 

  • Lobby for the reduction of Alberta property taxes to oil and gas companies and provide long-term stable funding for Alberta counties by other means.

 

  • Create a long-term strategic plan for development and production of long-life reserves of conventional natural gas.

 

  • Develop a coordinated plan to secure financial backing for this plan.  Those who financially backed the U.S. LNG terminals are those with the greatest incentive.

 

  • Canadian Association of Petroleum Producers (CAPP) should take an integrated view of the industry, one that includes greater recognition of small and medium sized producers.

 

  • Create and implement a media strategy which communicates to U.S. interests that investing E&P budgets in conventional Canadian natural gas is an excellent growth strategy.

 

Getting to this point has entailed plans with too much short-term thinking. Typical boom and bust cycles are create significant problems for all concerned and forward thinking now will make it better for everyone.

 

In Alberta, the mid-1980’s bumper sticker said, “Lord, grant me another boom, I promise not to piss it way.”  The next boom for the Canadian oil and gas industry will be supplying natural gas to the United States.  Will we see the opportunity and do what it takes to make the best of it?

 


About the Author

 

Richard Wilkie has a B. Admin and an MBA with over twenty-five years in the oil and gas industry. His experience with strategic and business planning extends to consulting projects and he is an expert speaker at conferences in Canada and the United States.


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